Money Market Funds: SEBI Rules, Instrument Types, and Credit Risk
A money market fund is an open-ended debt mutual fund scheme that invests exclusively in short-term money market instruments with a maturity of up to one year. Regulated under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, these schemes deploy capital into commercial paper, certificates of deposit, Treasury bills, and tri-party repo transactions.
A persistent error on personal finance websites is applying United States mutual fund rules to Indian portfolios. In the United States, money market funds operate under SEC Rule 2a-7, seeking to maintain a stable Net Asset Value (NAV) of $1.00 per share. In India, money market mutual funds do not maintain a fixed NAV. The daily net asset value reflects the mark-to-market valuation of all underlying money market securities. Unit values fluctuate daily based on interest rate shifts, liquidity conditions, and issuer credit quality.
Dhanvantri Capital Services Private Limited, known as Dhanvantree, is an AMFI-registered mutual fund distributor, ARN-194216, and a distributor of portfolio management services registered with APMI, APRN10201. We are not registered investment advisers. This page explains regulatory structures, instrument categories, operational procedures, and direct tax rules for Tax Year 2026-27. It evaluates no individual scheme and sets no course of action. The choice is yours.
How SEBI defines a money market fund
Under the consolidated SEBI Master Circular for Mutual Funds dated 20 March 2026, the capital markets regulator classifies debt mutual fund schemes by the maturity profile of their underlying securities.
SEBI establishes a strict investment boundary for this category:
Category Definition: An open-ended debt scheme investing in money market instruments having a maturity of up to one year.
Permitted Asset Universe: The scheme can only purchase securities that have a residual maturity of 365 days or less at the time of purchase.
Eligible Borrowers: Issuers include the Government of India, scheduled commercial banks, public financial institutions, and corporate borrowers.
Within the SEBI classification framework for debt schemes detailed across types of mutual funds, maturity mandates determine portfolio boundaries. A money market fund cannot purchase three-year corporate bonds or ten-year government securities as ordinary portfolio holdings. If an instrument has a residual maturity exceeding one year, it is legally barred from the portfolio.
The one-year ceiling applies to the instruments acquired by the fund. It does not impose a mandatory one-year lock-in on the unitholder. Furthermore, the fund manager is not required to hold every security until final maturity. The manager may trade eligible instruments in the secondary market to adapt to changing yields and liquidity requirements.
Overnight vs liquid vs money market funds
To understand where money market funds fit, investors must evaluate how SEBI differentiates short-term debt schemes by portfolio maturity and liquidity rules:
| Regulatory Parameter | Overnight Funds | Liquid Funds | Money Market Funds |
|---|---|---|---|
| SEBI Maturity Mandate | Securities with maturity of 1 day only | Debt and money market securities with maturity up to 91 days only | Money market instruments with maturity up to 1 year only |
| Primary Holdings | Overnight TREPS and reverse repos | T-bills, short-term commercial paper, and certificates of deposit (CDs) | Certificates of deposit (CDs), commercial paper, T-bills, and TREPS |
| Interest Rate Sensitivity | Virtually zero duration risk | Minimal duration risk (under 91 days) | Moderate duration risk (up to 365 days) |
| Mark-to-Market Impact | Negligible price fluctuation | Low price fluctuation | Observable daily price fluctuation |
| Mandatory Exit Load | Nil exit load | Graded exit load for redemptions within 7 days | No uniform mandatory 7-day exit load |
| Typical Deployment Horizon | 1 day to 1 week | 1 week to 3 months | 3 months to 12 months |
Note: This comparison reproduces the supplied educational content. Actual portfolio maturity limits, exit-load provisions, and risk characteristics should be checked against current SEBI regulations and individual scheme documents.
For deploying cash across a single business day, institutional treasuries rely on overnight funds to eliminate duration risk. Investors with investment horizons of a few weeks often utilize liquid funds, which hold instruments maturing within 91 days.
Money market funds sit further along the maturity curve. Because their underlying securities run up to 365 days, they carry higher duration sensitivity than liquid schemes while capturing prevailing one-year money market yields.
However, the one-year maturity ceiling does not mean every money market fund maintains the same duration. A scheme concentrated in short-dated paper behaves differently from a scheme holding significant allocations in nine-month commercial paper.
What a money market fund actually buys
A money market mutual fund does not purchase equity shares. The fund manager allocates capital across four primary short-term debt instruments governed by the Reserve Bank of India and the Securities and Exchange Board of India:
1. Treasury Bills (T-Bills)
Short-term sovereign paper such as 91-day, 182-day, and 364-day Treasury Bills originates directly from central government debt issuances detailed under government securities.
T-bills carry negligible domestic-currency credit risk because they represent direct sovereign obligations of the Government of India. They pay no periodic coupon interest; they are issued at a discount and redeem at par. Fund managers utilize T-bills to manage liquidity and maintain strong credit quality across the portfolio.
2. Commercial Paper (CP)
Commercial paper consists of unsecured short-term promissory notes issued by eligible corporate entities, primary dealers, and Non-Banking Financial Companies (NBFCs) under RBI directions.
Issuing Purpose: Borrowers issue CP to finance working capital requirements and bridge short-term cash flow gaps.
Tenure Range: CPs are issued with maturities ranging from 7 days up to one year.
Denomination: Issued in minimum denominations of ₹5 lakh and multiples of ₹5 lakh thereafter.
Issue Structure: Issued at a discount to face value and redeemed at par.
Credit Exposure: CPs are unsecured borrowings that create no charge over company assets. Repayment depends entirely on the issuer’s financial capacity and cash flow solvency.
Because commercial paper carries issuer-specific credit risk, fund managers evaluate issuer financial health, credit ratings, cash flows, and overall group exposure.
3. Tri-Party Repo (TREPS)
Tri-party repo is a collateralized short-term borrowing and lending facility.
Collateral Infrastructure: One participant borrows funds by providing eligible government securities as collateral, while another participant lends funds against that collateral.
Settlement Guarantee: The Clearing Corporation of India Limited (CCIL) operates as the central counterparty, providing clearing and settlement infrastructure that absorbs counterparty settlement risk.
Cash Deployment: Fund managers deploy daily operational cash surpluses into TREPS to generate returns on undeployed balances while preserving immediate liquidity.
CCIL infrastructure manages settlement execution. It does not guarantee scheme returns or protect against NAV fluctuations.
Certificates of deposit: issuance rules, tenures, and mechanics
Certificates of Deposit (CDs) represent a core asset class for money market mutual funds. A Certificate of Deposit is a negotiable, unsecured money market instrument issued in dematerialized form by eligible banking institutions and financial entities.
In India, bank-issued CDs are governed by the Reserve Bank of India (Certificate of Deposit) Directions, 2021. Eligible All-India Financial Institutions (AIFIs) operate under corresponding RBI resource-raising directions.
Eligible Issuers and Regulatory Boundaries
Under RBI Master Directions, only designated financial institutions can issue Certificates of Deposit:
Scheduled Commercial Banks (SCBs): Public sector and private sector commercial banks operating in India.
Regional Rural Banks (RRBs) and Small Finance Banks (SFBs): Permitted to issue CDs to diversify their short-term funding base.
Select All-India Financial Institutions: Specific apex institutions, including NABARD, SIDBI, NHB, and EXIM Bank, permitted by the RBI to raise short-term resources.
Minimum Denominations and Maturity Limits
The RBI establishes strict structural conditions for CD issuances:
| Operational Parameter | Bank-Issued CDs | AIFI-Issued CDs |
|---|---|---|
| Minimum Denomination | ₹5 lakh | ₹5 lakh |
| Additional Increments | Multiples of ₹5 lakh | Multiples of ₹5 lakh |
| Minimum Maturity | 7 days | 1 year |
| Maximum Maturity | 1 year | 3 years |
| Issuance Format | Dematerialized book-entry format | Dematerialized book-entry format |
Note: Figures and issuance conditions are reproduced as supplied. Verify current RBI directions before using this table as regulatory guidance.
Discount vs Floating Pricing
Certificates of Deposit are commonly issued at a discount to their nominal face value and redeemed at par upon maturity:
Secondary Market Trading and Buyback Rules
Certificates of Deposit are fully transferable through secondary market arrangements on recognized electronic platforms and exchanges.
Under RBI Master Directions, specific operational conditions apply to CD buybacks:
The Seven-Day Rule: An issuing bank can buy back its own CDs before maturity, but only after a minimum holding period of seven days from the original issue date.
Universal Offer Terms: The buyback offer must be made to all investors in that specific issue on identical terms. Investors retain the freedom to accept or reject the offer.
Prevailing Market Price: Buybacks must occur at prevailing market prices.
Extinguishment: All CDs bought back by the issuing institution are immediately extinguished.
Banks are generally prohibited from granting loans against their own CDs unless specifically authorized by the RBI. Money market funds provide essential secondary liquidity by acquiring CDs from bank primary issuances and secondary trading desks.
The credit risk reality: money market funds are not bank deposits
A common retail misconception is believing that because an instrument has “money market” in its name, it carries the same protections as a commercial bank deposit.
Money market funds are market-linked mutual fund investments. Their units are not insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). DICGC insurance protects bank deposits up to ₹5 lakh per depositor across accounts held in the same capacity and right within an insured bank, covering principal and interest combined. Mutual fund units receive zero statutory insurance backing.
Understanding Default, Downgrade, and Liquidity Risks
The credit risk of a money market fund depends directly on the borrowers held in its portfolio:
Default Risk: If a corporate borrower defaults on its commercial paper at maturity, the mutual fund suffers an immediate mark-to-market loss.
Credit Rating Downgrades: If an issuing company experiences operational deterioration, credit rating agencies may downgrade its short-term debt rating. A downgrade causes the market price of that paper to drop, reducing the scheme’s NAV.
Liquidity Risk: During credit crunches, secondary market trading in corporate debt can freeze. If large redemption requests hit the fund, the fund manager may have to sell liquid sovereign assets, leaving the remaining portfolio concentrated in less liquid paper.
SEBI Portfolio Concentration Limits
To prevent excessive exposure to single borrowers, SEBI enforces strict investment limits across debt mutual fund schemes:
Single-Issuer Limit: A scheme cannot invest more than 10 percent of its Net Asset Value in debt and money market securities issued by a single corporate issuer.
Trustee Extension: With prior approval from the AMC Board and Trustee Board, this threshold can be extended to 12 percent of NAV.
Exemptions: Sovereign securities, Treasury bills, and government-backed tri-party repo exposures are exempt from this corporate single-issuer cap.
These statutory caps mitigate concentration risk, but they do not eliminate credit risk or guarantee that borrowers will fulfill their obligations
Interest rate risk and mark-to-market NAV pricing
While credit risk relates to issuer default, interest rate risk relates to bond price fluctuations prior to maturity.
Because money market funds hold paper with maturities of up to 365 days, portfolio values remain exposed to interest rate cycles. Bond prices and market yields move in opposite directions:
All else being equal, when market interest rates rise, existing fixed-income securities with lower coupon rates generally become less attractive, causing their market prices to fall.
Daily Valuation Mechanics
Under SEBI valuation guidelines, debt and money market securities are valued on a daily mark-to-market basis using valuation matrices provided by independent agencies (such as CRISIL and ICRA).
Even when an issuer has an impeccable credit rating, a 25-basis-point increase in one-year benchmark yields causes the market price of its paper to soften. Consequently, a money market fund’s NAV does not move in an unbroken straight line. It fluctuates daily based on market yields.
An investor who redeems units after holding a money market fund for only a few days can experience a negative return if market interest rates spike during that brief holding window.
Operational rules: exit loads, cut-offs, and liquidity
Money market mutual funds function under defined operational guidelines established by SEBI:
1. Exit Load Structures
Liquid funds are legally required by SEBI to enforce a mandatory graded exit load on redemptions occurring within the first seven days (starting at 0.0070 percent on Day 1 and reducing to zero on Day 7).
Money market funds do not carry this universal mandatory seven-day exit load framework. While most money market funds do not deduct an exit load on redemption, investors must verify individual Scheme Information Documents. Certain asset management companies specify an exit load for redemptions executed within a short initial window.
2. Transaction Cut-Off Timings
Money market funds follow standard non-liquid debt scheme transaction cut-off rules:
Purchase Cut-Off at 3:00 PM: For a purchase application submitted before 3:00 PM on a business day, the closing NAV of that day applies only if the entire subscription amount is available for utilization by the fund before 3:00 PM. If funds are realized after 3:00 PM, the NAV of the business day on which funds become available is allotted.
Redemption Cut-Off at 3:00 PM: For redemption applications logged before 3:00 PM on a business day, the closing NAV of the same day applies. Applications received after 3:00 PM receive the NAV of the next business day
3. Redemption Payout Timelines
Under current SEBI regulations, asset management companies must dispatch redemption proceeds to investors within three working days from the date of redemption. Specific exceptional circumstances may permit extended settlement windows under regulatory guidelines.
Investors should distinguish the date on which a transaction receives its applicable NAV from the date redemption funds arrive in their bank account.
4. Mandatory 10% Liquid Asset Buffer
Under SEBI circular directives, open-ended debt mutual funds must maintain at least 10 percent of their net assets in liquid assets on an ongoing basis.
This liquid buffer must consist of cash, government securities, Treasury bills, or repo against sovereign paper. The requirement ensures that money market funds can meet routine investor redemptions without being forced to liquidate less active corporate holdings at a loss.
Taxation under Section 76: the direct tax framework
For Tax Year 2026-27, the taxation of debt mutual funds is governed by Section 76 of the Income-tax Act, 2025.
Deemed Short-Term Capital Gains
Under Section 76, a mutual fund that invests more than 65 percent of its total proceeds in debt and money market instruments falls into the statutory category of a specified mutual fund:
Statutory Threshold: The 65 percent allocation is evaluated based on the annual average of daily closing portfolio values. Because money market funds invest exclusively in debt instruments, they meet this definition.
Elimination of Long-Term Status: For units acquired on or after 1 April 2023, capital gains arising on transfer, redemption, or maturity are legally deemed to be short-term capital gains.
No Indexation Allowances: Indexation benefits using the Cost Inflation Index are not permitted.
Taxation at Personal Slab Rates: All capital gains are added to your gross total income and taxed at your applicable personal income tax slab rate. Holding units for more than 12, 24, or 36 months does not qualify for concessional tax rates.
All capital gains from these schemes are assessed under direct tax rules governing short term capital gain tax on mutual funds at personal slab rates.
Worked Tax Calculation
Suppose an investor redeems money market fund units and realizes a capital gain of ₹50,000. Assume the investor falls into the 30 percent marginal tax bracket:
| Tax Component | Statutory Calculation | Tax Liability |
|---|---|---|
| Capital Gain Realized | Net redemption proceeds minus purchase cost | ₹50,000 |
| Basic Income Tax | Flat 30% rate applied to gain | ₹15,000 |
| Health and Education Cess | 4% cess on basic income tax | ₹600 |
| Total Statutory Tax | Effective tax rate of 31.2% (excluding surcharge) | ₹15,600 |
Note: This is an illustrative calculation using the supplied 30% tax rate and 4% cess. Actual capital gains taxation depends on the asset, holding period, applicable tax provisions, investor status, and relevant financial year.
If the taxpayer’s total annual income exceeds statutory thresholds, applicable surcharge rates apply in addition to basic tax and cess.
Tax Withholding on IDCW Payouts under Section 393
If an investor chooses the Income Distribution cum Capital Withdrawal (IDCW) option, dividend distributions are fully taxable in the investor’s hands at personal slab rates.
Under Section 393 of the Income-tax Act, 2025, asset management companies must deduct 10 percent Tax Deducted at Source (TDS) on qualifying mutual fund income distributions paid or credited to a resident investor when aggregate payouts exceed ₹10,000 in a financial year. TDS represents an advance tax collection, not the final tax liability.
Evaluating money market funds
Allocating capital to a money market fund involves weighing yield, liquidity needs, and risk tolerance:
A money market fund may align if: You have surplus funds to deploy for 3 to 12 months, you want higher yield potential than overnight or liquid funds by accepting modest duration, and you can accept minor daily mark-to-market NAV fluctuations.
A money market fund may not align if: You require immediate emergency cash within 24 to 48 hours (where overnight or liquid funds provide lower duration risk), you expect bank deposit insurance, or you seek long-term equity growth.
Review the portfolio’s credit rating distribution, examine the scheme’s Risk-o-meter rating, and verify direct tax liabilities before committing capital.
The choice is yours.
Common questions about money market funds
Under SEBI regulations, a money market fund can only invest in debt and money market securities that have a residual maturity of up to one year (365 days).
No. While a fund may launch at an initial face value of ₹10, Indian mutual funds value their holdings on a daily mark-to-market basis. The NAV fluctuates daily reflecting market prices and yields.
Under RBI Master Directions, CDs can be issued by scheduled commercial banks, Regional Rural Banks, Small Finance Banks, and select All-India Financial Institutions like NABARD, SIDBI, NHB, and EXIM Bank.
Under RBI regulations, the minimum denomination for a Certificate of Deposit is ₹5 lakh, with additional issuances accepted in multiples of ₹5 lakh thereafter.
No. DICGC insurance applies exclusively to eligible deposits with insured banks up to ₹5 lakh per depositor. Mutual fund units carry no statutory deposit insurance.
The standard purchase cut-off time is 3:00 PM on business days. The same day’s closing NAV applies only if the entire investment amount is available for utilization by the scheme before the 3:00 PM cut-off.
Under Section 76 of the Income-tax Act, 2025, gains from specified mutual funds acquired on or after 1 April 2023 are classified as deemed short-term capital gains, taxed at the investor’s personal slab rate regardless of holding duration.
Disclaimer: The views expressed here are of the author and do not reflect those of Dhanvantree. Mutual funds are subject to market risks, please read the scheme documents carefully before investing.